CH07[1][1] - CHAPTER 7 INTERCOMPANY INVENTORY TRANSACTIONS...

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CHAPTER 7 INTERCOMPANY INVENTORY TRANSACTIONS ANSWERS TO QUESTIONS Q7-1 All inventory transfers between related companies must be eliminated to avoid an overstatement of revenue and cost of goods sold in the consolidated income statement. In addition, when unrealized profits exist at the end of the period, the eliminations are needed to avoid overstating inventory and consolidated net income. Q7-2 An inventory transfer at cost results in an overstatement of sales and cost of goods sold. While net income is not affected, gross profit ratios and other financial statement analysis may be substantially in error if appropriate eliminations are not made. Q7-3 An upstream sale occurs when the parent purchases items from one or more subsidiaries. A downstream sale occurs when the sale is made by the parent to one or more subsidiaries. Knowledge of the direction of sale is important when there are unrealized profits so that the person preparing the consolidation workpaper will know whether to reduce consolidated net income by the full amount of unrealized profits (downstream) or to reduce consolidated income and income to noncontrolling shareholders on a proportionate basis (upstream). Q7-4 As in all cases, the total amount of the unrealized profit must be eliminated in preparing the consolidated statements. When the profits are on the parent company's books, consolidated net income is reduced by the full amount of the unrealized profit. Q7-5 The full amount of the unrealized profits are again eliminated. In the upstream sale, however, the unrealized profits are apportioned between the parent company shareholders and the noncontrolling shareholders. Thus, consolidated net income is reduced by a pro rata portion of the unrealized profits on an upstream sale. Q7-6 Income assigned to the noncontrolling interest is affected when unrealized profits are recorded on the subsidiary's books as a result of an upstream sale. A downstream sale should have no effect on the income assigned to noncontrolling interest because the profits are on the books of the parent. Q7-7 The basic eliminating entry needed when the item is resold before the end of the period is Sales XXXXXX Cost of Goods Sold XXXXXX McGraw-Hill/Irwin
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The debit to sales is based on the intercorporate sale price. This means that only the revenue recorded by the company ultimately selling to the nonaffiliate is to be included in the consolidated income statement. Cost of goods sold is credited for the amount paid by the purchaser on the intercorporate transfer, thereby permitting the cost of goods sold recorded by the initial owner to be reported in the consolidated statement. Q7-8 The basic eliminating entry needed when one or more of the items are not resold before the end of the period is Sales XXXXXX Cost of Goods Sold XXXXXX Inventory XXXXXX The debit to sales is for the full amount of the transfer price. Inventory is credited for the unrealized profit at the end of the period and cost of goods
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